She can be contacted at [email protected].
post on this topic, and supplements the analysis in that post.]
debentures/ preference shares has been a gray area from the regulatory perspective
in India for years. These instruments did not find their eligibility under the
FDI norms or Securities Contract (Regulations) Act, 1956 (SCRA) provisions and
did not have the nod from SEBI and RBI either. The position for such
instruments remained ambiguous till SEBI’s notification on enforceability of
pre-emption right and call and put options in securities of Indian companies
and the recent RBI notification that followed thereafter which expressly granted
eligibility to such instruments under the FDI regulations. This post elucidates
on the latest developments in this segment and its impact thereof.
optionality clause instruments for FDI
dated 9th January 2014 issued the pricing guidelines for FDI
instruments with optionality clauses. RBI has permitted issuance of equity
shares or compulsorily convertible preference shares/ debentures with
optionality clauses to foreign investors under the extant FDI scheme with a
view that such optionality clauses will permit exit mechanism for the
investors. The condition precedent to such eligibility is that such instruments
should not provide for an assured return as it gets a color of debt and not
equity or equity type investment and is subject to certain conditions as well. The
provisions of the optionality clauses are made subject to the following
higher lock-in period as prescribed under FDI regulations. The lock-in shall be
effective from the date of allotment of such shares/ debentures.
investor shall be allowed to exercise the option to exit without any assured
prevailing market prices at a recognised stock exchange.
eligible to exit at a price not exceeding that arrived at on the basis of
Return of Equity (RoE)
as per the last audited balance sheet of the investee company.
debentures/ preference shares can be transferred at a price worked out as per
internationally accepted pricing methodology at the time of exit duly certified
by a Chartered Accountant or SEBI registered merchant banker.
existing contracts will have to qualify with the above conditions to be FDI
that may work for foreign investors when they invest through such instruments
whether with or without options. The situation that emerges from this
notification and under the extant FDI policy with regard to equity shares and
convertible instruments is discussed below.
buy the equity shares with or without option, in case of listed companies, they
can buy the shares at a price not less than as determined as per the SEBI
pricing guidelines and in case of unlisted companies the foreign investors can
buy shares fair valued as per DCF method done by SEBI Merchant Banker or
is what makes several combinations mechanisms possible for investors. In case
the foreign investors investing in equity shares of listed company with
optionality clause, the investor will buy the shares at a price determined by
SEBI pricing guidelines and can sell at the prevailing market price at a
recognised stock exchange. In case the foreign investors invest in equity
shares of unlisted company with optionality clause, the investor will buy
shares at a fair valued price as per DCF method but will sell shares at a price
arrived on the basis of RoE of the company as per last audited balance sheet.
convertible instruments, when the foreign investor has to buy the compulsorily
convertible preference shares/ debentures with or without option, in case of
listed companies, they can buy the instruments at a price determined as per the
SEBI ICDR guidelines and in case of unlisted companies the foreign investors
can buy instruments fair valued as per DCF method done by SEBI Merchant Banker
or Chartered Accountant.
available after the RBI’s notification, if the instrument were issued with
optionality clause, the instrument is to be sold at a price arrived as per the
internationally accepted pricing methodology, whereas if the instruments were
issued without optionality clause, the instrument is to be sold at a conversion
price not lower than fair value arrived at the time of issuance.
from the RBI notification are as follows:
unlisted company, where the investor has to purchase at a price arrived at
future projections but will have to exit at prices based on or linked to RoE as per last audited balance sheet. The observations
Hence the shareholders’ agreement will have to clearly lay down the exit price
computation linked to RoE.
investor, the investor will let the option expire and shall sell the shares at
the market price which may be reflective of the fundamentals of the company.
This gives investors flexibility of choosing mode of exit within the same
If the instrument is issued with option the foreign investors have more
flexibility in choosing the mode of valuation of the instrument as long as it
is internationally acceptable methodology.
foreign investors has made the investment domain open and available for further
Companies Act, 2013
transferability of shares or interest of a member, in case of a public company.
However, the proviso
to the section seeks to give recognition to restrictions on transfer in
shareholders’ agreements, thereby covering preferences like right of first
a prohibition on forward dealings in securities of company by directors or key
managerial personnel. The section states that the director or key managerial
personnel shall not have the right to call for delivery or make delivery of any
shares or debentures in the company, its holding, subsidiary or associate
company. The contravention with the provisions of this section are severe and
are punishable with imprisonment which may extend upto 2 years or fine which
shall not be less than Rs. 1 lac which may extend upto Rs. 5 lacs or with both.
directors and the key managerial person and not on the relatives of such persons.
Further, writing of a call is not barred under this section also, if the right
to call for delivery or right to make delivery is at market price then such
transaction is not barred by this section.
public offer, buy-back of shares by the investee company, optionality clauses
(call/ put options), tag along/ drag along rights, trade sales etc. However the
optionality clause renders flexibility in devising the strategy for investment
for the foreign investors. For instance a call option allows the investors to
increase the stake in the investee company and is useful where the investors
are actively involved in the functionality and operations of the company. The
call option allows foreign investors to increase their shareholding when
desired or as permissible under the regulations. Likewise put options permits
foreign investors to reap the benefit of their investments when the valuation
of the investee company increases.
investors investing in Indian entrepreneurs. The investment deals were brimming
with opportunities for private equity investors, eyeing angel investments in
India increasingly in 2009-10 and first half of 2011. Several investments deals
were undertaken with pre-emption rights/ optionality clauses as commonly used
exit options. India had become a hot destination for global private equity
investors to expand their allocations to India next only to China and the
global financial crisis of 2008 aided in channelizing the funds to India. This
continued till the first two quarters of 2011. However the situation changed
drastically, when the regulators raised concerns on issuance of equity shares/
compulsory convertible debentures/ preference shares with optionality clause
and put an express bar on such instruments under the FDI norms in 2011. There
was a 25% decline in private equity investments in the first three quarters of
2012 as compared to the similar period in 2011. With regard to exits, while the
volumes of exit increased during 2012, the exit values fell substantially from
USD 1.8 billion to USD 1.1 billion.
This was later withdrawn due to sharp criticism from the investors’ community.
offering as an exit mechanism has greatly diminished considering the state of
the capital markets; with the permissibility of such instruments and
pre-emption rights along with the amendments in the Companies Act, 2013 will
pave way for these investors to keenly consider other exit options. The
relaxation in the FDI norms is an attempt to facilitate FDI inflows into the
country which had dropped substantially in 2013
and these amendments seem to be supportive to the cause from the regulatory
perspective. Also what is paramount to the investors is some clarity in
regulations which was missing all this while; hence the RBI notifications
probably will be welcomed by the investors’ community.
– Nidhi Bothra
shall mean profit after tax/ net worth; networth would include paid-up capital
and all free reserves.
Act, 2013 stipulates “any contract
or arrangement between two or more persons in respect of transfer of securities
shall be enforceable as a contract“.
India dropped by 15% between April-October, 2013